Internal performance contracting is a financing scheme in which organisational units within a municipality are contracted to implement a project without the need for external financiers. For example, energy efficiency measures could be financed through reduced energy costs.
The municipal budget supplies most of the initial financing, for example, by setting up a dedicated revolving fund or trust. Internal Contracting is therefore a variation on the internal revolving fund model. The fund or trust can finance energy efficiency or other emission reduction measures without any extra charges and at a 0% interest rate. Creating a fund or trust of this kind requires political support and commitment from the department(s) responsible for the budget and must be compatible with the existing legal framework (EnergyCities 2016; Irrek et al. 2005).
The ‘internal contractor’, normally allocated to an Energy Savings Company (ESCO), usually takes over an organisational unit within the municipality (such as the environmental department or a municipally owned company) which has the human resources as well as the required expertise to prepare and implement such projects successfully. The internal contractor assesses energy savings potentials, calculates the investment costs and payback period and plans the project. When the project is implemented, the trust or funds are slowly replenished by the cost savings until the initial investment is recovered. The recovered capital is then reinvested in new projects. (EnergyCities 2016; Junghans and Dorsch 2015; Novikova 2017).
Advantages: The main advantage of this model is that the municipality can self-finance the project without the need of external investors and without the strain of multiple investments from the municipality. This model allows municipalities to use energy savings to finance energy efficiency initiatives by reinvesting the recovered capital in new energy efficiency projects. The concept helps bridge the typical gap between operating budgets and municipal investment by fostering cooperation across the departments within a municipality. This strategy allows for the funding of small projects or unattractive projects to private investors with an interest rate of 0%. Additionally, administrative and transaction costs are reduced, and compared to external contracting, the required legal paperwork is substantially simpler. (EnergyCities 2016).
Disadvantages: Similar to the limitations of municipal budget financing, this financing model is not attractive due to limited financial resources as well as the need for sufficient human resources and technical expertise which poses a common constraint with many municipalities and poses one of the biggest risks for this type of financing model. In many cases there can also be legal restrictions for the setting up such a fund. Moreover, the projects reflect on the balance sheet, which implies that the municipality bears all investment risks. Furthermore, empirically, projects financed by municipalities tend to be less successful in execution than those backed by private investors, which is partially due to the lack of project-specific know-how. Projects inefficiently implemented might fail to recover the expected energy savings and reduced recovery of invested capital (Junghans and Dorsch 2015; Seifried 2011).
Projects that can be financed with this model: Projects where the municipality possesses the required human resources as well as the technical expertise are most suited for this type of funding. Improvements to municipal infrastructure including combined power and heat plants, street lighting and energy efficiency are some of the proposals being considered. The maximum allowable project size is contingent upon the total amount of finance that is made available. The model is particularly attractive for projects related to energy-savings measures in public buildings, where it finds application most commonly (Novikova 2017).
Prepare a needs assessment report
Review the required capital, period of investment, available own budgetary resources, available human resources and technical expertise and the urgency of the project
Review available grants or low interest loans
Develop a financial plan for the internal revolving fund to identify the required initial capital, recovery time, reinvestment and the period for complete execution of the project
Review the various options of setting up an internal contracting fund based on legal restrictions
Review whether internal contracting is the best suited option based on the above analysis
EnergyCities. 2016. “Internal Contracting (Intracting). The City of Stuttgart. Fact Sheet.”
Irrek, W., Attali, S., Benke, G., Borg, N., Figorski, A., Filipowicz, M., Ochoa, A., Pindar, A., Thomas, S. 2005. “Testing and Dissemination of Public Internal Performance Contracting Schemes with Pilot Projects for Energy-Efficient Lighting in Public Buildings (PICOLight).”
Junghans, L., Dorsch, L. 2015. “Finding the Finance. Financing Climate Compatible Development in Cities.” Germanwatch e.V.
Novikova, A., Stelmakh, K., Hessling, M., Emmrich, J., and Stamo, I. 2017. Guideline on finding a suitable financing model for public lighting investment: Deliverable D.T2.3.3 Best practice guide. Report of the EU-funded project “INTERREG Central Europe CE452 Dynamic Light”, October 2017
Seifried, D. 2011. “Finanzierungsmodelle für das kommunale Energiemanagement.”